ARK Invest and Cathie Wood have certainly had a rough 2022. Shares of the flagship ARK Innovation ETF are down 59% year to date, but many people still have faith in ARK's work: The company's Innovation ETF has almost $7.7 billion in assets under management, and its other ETFs have billions of dollars too.
Two of ARK Invest's top holdings across all its ETFs are Block (SQ 5.04%) and Twilio (TWLO 2.94%). Both have dropped like stones this year, but their prospects are still bright, and long-term investors might want to take advantage of these low prices. Here's why you should follow in Cathie Wood's footsteps and buy these two companies.
1. Block
Block, formerly known as Square, is one of the top dogs in the fintech industry in the U.S., with market-leading products for both consumers and small businesses. It has a thriving peer-to-peer payments platform, Cash App, that generated over $624 million in gross profit in the first quarter, along with Square, its system that helps small businesses with everything from banking to marketing to the point of sale.
Square has been incredibly successful, with nearly $40 billion in gross payment volume in Q1, yet it has historically made little progress internationally. In Q1 2020, just $22 million of gross profit came from outside the U.S. However, management is now prioritizing Square's international expansion. In Q1 2022, the Square ecosystem generated $78 million in international gross profit, a 255% increase in just two years.
This endeavor will require continued investment, but Block has the cash to do so. In Q1, the company generated over $188 million in free cash flow, which can fuel these investments across borders.
A risk to the industry in the short term is interest rate hikes in the U.S., which will make it more expensive to borrow money. Block, however, has almost $4.8 billion in cash and investments on its balance sheet to help it avoid borrowing.
While a recession could hurt the company, it offers essential products for any small business. While there might be less activity during a recession, the chances are slim that customers will get rid of their Square products altogether. Additionally, the Cash App has embedded itself into consumers' daily habits, which could help it to retain users during an economic downturn.
Shares trade at 31 times free cash flow -- one of its lowest valuations since the company went public in 2015 -- making Block attractive right now. While activity on the Cash App and Square will both slow if a recession hits, shares could be wildly undervalued today if the company can maintain its strength in the U.S. while making progress internationally. Cathie Wood seems to think shares are cheap, and you might want to follow in her footsteps.
2. Twilio
Twilio's dominant position in the business-to-consumer communication industry has been a force to be reckoned with in the past, and its continuing innovation is only making it harder for rivals to compete.
The company thrives not only on its leadership in the space but also on its wide-reaching product suite. It offers services for every digital channel of communication you can think of, and it even has its own data platform where companies can develop personalized communications to drive business. Additionally, Twilio's application programming interfaces are robust enough to power large businesses like MercadoLibre and Salesforce (CRM 1.05%), yet simple enough to be used by any developer.
While its customers could experience a decline in activity, businesses might need Twilio more than ever during a recession. If consumers consider cutting a specific service, businesses might want to pay a premium for personalized communications to retain that consumer. This could allow Twilio to perform well during an economic downturn.
Twilio has over $5.2 billion in cash and securities to help it weather rising interest rates. The bigger risk for Twilio, however, is its net losses. While the company had roughly break-even free cash flow in Q1, it had an operating loss of $217.8 million over the same period. Management has noted, however, that this won't be as big a concern in the future. By 2023, the company forecast that it expected to reach non-GAAP (generally accepted accounting principles) operating profitability and remain consistently so in the future.
While dark clouds loom, Twilio looks prepared to come out stronger on the other side. ARK Invest also clearly believes Twilio can survive the uncertain economic environment, considering it is ARK's 10th-largest position in all of its ETFs combined. Because of that, the company's valuation of 4.8 times sales looks quite appealing. Additionally, this valuation is the lowest it has ever been since coming public in 2016, so investors can buy shares at a rock-bottom price today.
